Opinion
Column

We’ve all seen the covers of books and magazines that note different prices in Canada versus the U.S. We’ve all been online and seen prices in the U.S. that were lower than Canada. And many people partake in cross-border shopping each year in search of lower prices.

When the Canadian dollar was trading below the U.S. dollar most people believed these price differences were largely due to the exchange rate. As such, when the Canadian dollar started to approach par (or higher), people started to question whether these price differences were justified. It was in response to such concerns that the Standing Senate Committee on National Finance initiated hearings on the Canada-U.S. price gap in the fall of 2011.

Now that the committee's report, with its findings and recommendations, has been released, should Canadian consumers expect to see a reduction in prices? My belief is that while prices may be reduced, it will be sometime before this report’s recommendations lead to any large-scale price reductions. Moreover, any price cuts that do occur will not be for the reasons many people suspect; nor will they be sourced in the areas many people suspect are responsible for the price gaps in the first place.

The Root of the Problem

The belief that currency valuations were solely responsible for price differences had many citizens believing that retailers were guilty of price-gouging. Interestingly, at the same time, many retailers felt captive to higher Canadian wholesale prices, and the resulting price gaps were encouraging Canadians to shop across the border, especially given the growth of online retailing. Small wonder that many people believed unfair profit-making was occurring and that some form of regulation was needed.

But appearances can be deceiving. Retail (and wholesale) pricing is far more complex than meets the eye.

The most common mechanism for setting prices is called “cost plus pricing.” Sellers adds up all the costs they incur and add what they consider a reasonable amount of profit margin. However, a retailer’s total cost reflects many things. These include manufacturer’s selling prices, currency exchange rates, shipping and handling, excise taxes, marketing costs and other related costs. The key point is that differences between U.S. and Canadian prices may be linked to differences in any of these costs, not just currency exchange rates.

For example, given our lower average population density and greater geographic dispersion, Canadian retailers often face higher shipping and handling costs and higher marketing costs than their U.S. counterparts. Moreover, U.S. retailers often receive lower prices from manufacturers due to the volume they generate servicing a population 10 times Canada’s. The lower costs to U.S. retailers means they can sell at a lower price, and many of those cost differences cannot be regulated away

Similarly, profit margins reflect many factors, the largest of which is the intensity of competition and law of supply and demand. While many retailers would have good cause to argue, Canada is considered a less-intensely-competitive retail environment because of the smaller number of retailers and the more limited shopping options once you leave the major metropolitan centres. As such, retail margins tend to be higher here than in the U.S. This is a major reason why so many U.S. chains are looking to set up shop in Canada.

If that complexity isn’t enough, the relative magnitude of the various cost elements and the intensity of competition (and thus retail margins) are not the same across all industries. For example, there will be some industries – like those selling high-value but physically small items – that don’t have high shipping costs and so we might not to see the price gap we would see in a business selling bulky, low-value goods. Some goods are heavily marketed, while others are not. Some goods are tariff-exempt while others are taxed … and so on. The same can be said for profit margins.

These complexities make it extremely difficult to extrapolate from one, or even a limited number, of examples to conclude there is a systemic problem or to conclude that price-gouging is occurring. Variations in the size of price gaps can exist for very legitimate reasons. As such, there is no magic number or easy formula that regulators could apply to determine whether a price gap is legitimate. Indeed, it is not hard to envision a scenario where the cost of detection would exceed the cost - at least the economic cost - of the problem.

The Future

The Senate committee’s recognition of the complexities in retail pricing sets the stage for a critical public reaction. I am sure that there are some who will criticize the report as “just another” pointless inquiry, given the lack of a resulting “silver bullet” that will eradicate all price gaps. At the same time, there likely will be others who will seize upon those same complexities to argue that regulation could never be fairly and practically implemented, regardless of public pressure to do so.

I do not agree with either view. Rather, I believe the committee should be applauded for resisting the “easy out” of taking either a totally hands-off position or over-regulating an already cost-burdened industry.

Implicit in the committee’s recommendations are two key positions. First, government should not be responsible for creating a bigger gap than natural market forces can justify. This is why it called for a review of tariffs, especially in the book industry. That said, since most tariffs have a protectionist origin, it is not clear whether a reduction in retail prices would lead to major losses of income and jobs in certain sectors: we can’t have it both ways.

Second, competition and consumer choice remain the best regulator. If Canadian retailers are charging higher margins than they should, that can only exist to the extent that Canadians are unaware of lower cost options or unable to buy from those sources. The report’s questioning of whether unnecessary duties and customs-clearing fees are making lower prices inaccessible is a move intended to safeguard consumer choice.

However, given that importing goods is not always a viable consumer option, the overall benefit of that recommendation is unlikely to be massive. It is a step in the right direction, but it is unlikely to sufficient to close the gaps completely.

Notwithstanding all of the above, I do think the price gap will close in many sectors. This will not be due to regulation, but competition. As large U.S. chains look north the number of competitors will increase, competition will become more intense and thus margins (and prices) will tend to fall: interestingly, the very characteristics of Canadian retailing that is attracting U.S. chains will cease to exist.

Moreover, as e-commerce continues to flourish, consumer knowledge of prices and access to U.S. websites will make it hard for those who would gouge consumers to continue to do so. Finally, as our mastery of logistics grows, the cost penalties of living in a geographically dispersed nation will shrink.

This does not mean we should expect the lowest possible price from all retailers. Even in a perfect world, where there were no price gaps between Canadian and U.S. stores, prices in some Canadian (and some American) stores would continue to be higher than at others stores in the same locale. This is because there is real value (and costs incurred) in providing superior technical advice, warranty service, a superior shopping experience and a greater quality and quantity of customer service.

If Canadians (or Americans) want and value those elements they must be prepared to pay for them. For example, using the showrooms and technical expertise of local retailers to decide what to buy and then buying from a low-cost retailer is, in my view, “stealing” from the local retailer: the only difference is that services, not products, are being taken without paying.

As with Canada-U.S. price gaps, not all price differences are sourced in the greed of the seller. The best way to protect the consumer against those who charge unjustifiably excessive prices is to insure the consumer’s access to information and safeguarding their access to a competitive marketplace.

Ken Wong is a faculty member in Queen’s School of Business and one of the expert witnesses who appeared before the Senate committee.